C22_international Krugman_12e_accessible.pptx

International Economics: Theory and
Policy
Twelfth Edition
Chapter 22
Developing Countries:
Growth, Crisis, and Reform
Copyright © 2022, 2018, 2015 Pearson Education, Inc. All Rights Reserved

Learning Objectives
22.1 Describe the persistently unequal world distribution of
income and the evidence on its causes.
22.2 Summarize the major economic features of developing
countries.
22.3 Explain the position of developing countries in the world
capital market and the problem of default by developing
borrowers.
22.4 Recount the recent history of developing-country financial
crises.
22.5 Discuss proposed measures to enhance poorer countries’
gains from participation in the world capital market

Preview
• Snapshots of rich and poor countries
• Characteristics of poor countries
• Borrowing and debt in poor and middle-income economies
• The problem of “original sin”
• Types of financial assets
• Latin American, East Asian, and Russian crises
• Currency boards and dollarization
• Lessons from crises and potential reforms
• Geography’s and human capital’s role in poverty

The Gap Between Rich and Poor
• Low income: most sub-Saharan Africa, India, Pakistan
• Lower-middle income: China, Caribbean countries
• Upper-middle income: Brazil, Mexico, Saudi Arabia,
Malaysia, South Africa, Czech Republic
• High income: United States, Singapore, France, Japan,
Kuwait

Table 22.1 Indicators of Economic
Welfare in Four Groups of Countries
Income Group
GDP per Capita
(2019 U.S. dollars)
Life Expectancy in
2018 (years)
Low-income 780 63
Lower middle-income 2,177 68
Upper middle-income 9,040 75
High-income 44,584 81
Source: World Bank, World Development Indicators.

Has the World Income Gap Narrowed
Over Time?
• While some previously middle- and low-income
economies have grown faster than high-income countries,
and thus have “caught up” with high-income countries,
others have languished.
– The income levels of high-income countries and some
previously middle-income and low-income countries
have converged.
– But the some of the poorest countries have had the
lowest growth rates.

Table 22.2 Output per Capita in Selected
Countries, 1960–2017 (in 2011 U.S. Dollars) (1 of 4)
Industrialized in 1960
Country
Output per Capita
1960
Output per Capita
2017
1960–2017
Annual Average
Growth Rate
(percent per year)
Canada 15,573 44,975 1.9
France 11,344 38,170 2.2
Germany 13,337 46,349 2.2
Italy 10,176 35,668 2.2
Japan 6,400 39,381 3.2
Spain 7,301 33,593 2.7
Sweden 14,478 45,844 2.0
United Kingdom 12,719 38,153 1.9
United States 17,319 54,586 2.0

Africa
Country
Output per Capita
1960
Output per Capita
2017
1960–2017
Annual Average
Growth Rate
(percent per year)
Kenya 1,952 3,090 0.8
Nigeria 2.665 5,270 1.2
Senegal 2.917 3,111 0.1
South Africa 7,204 12,004 0.9
Zimbabwe 1,132 1,914 0.9

Latin America
Country
Output per Capita
1960
Output per Capita
2017
1960–2017
Annual Average
Growth Rate
(percent per year)
Argentina 9,283 16,432 1.0
Brazil 3,995 14,066 2.2
Chile 5,734 22,123 2.4
Colombia 4,059 13,585 2.1
Costa Rica 4,329 14,712 2.2
Mexico 6,633 16,792 1.6
Paraguay 2,618 8,948 2.2
Peru 5,135 11,808 1.5
Venezuela 11,935 11,321 negative 0.1
0.1


Asia
Country
Output per
Capita 1960
Output per
Capita 2017
1960–2017
Annual Average Growth Rate
(percent per year)
China 815 13,465 5.0
Hong Kong 4,459 50,271 4.3
India 1,048 6,548 3.3
Indonesia 1,635 11,173 3.4
Malaysia 2,639 24,574 4.0
Singapore 4,368 69,150 5.0
South Korea 1,573 36,999 5.7
Taiwan 2,070 43,501 5.5
Thailand 1,162 14,884 4.7
Note: Data are taken from the Penn World Table, Version 9.1, and use PPP exchange rates to compare national incomes
(variables RGDPNA/POP). For a description, see the Penn World Table website at
https://www.rug.nl/ggdc/productivity/pwt/ .

Structural Features of Developing
Countries (1 of 5)
• What causes poverty is a difficult question, but low-income
countries have at least some of following characteristics, which
could contribute to poverty:
1. Government control of the economy
– Restrictions on trade
– Direct control of production in industries and a high level of
government purchases relative to GNP
– Direct control of financial transactions
– Reduced competition reduces innovation; lack of market
prices prevents efficient allocation of resources

Figure 22.1 Richer Countries Have Become
Less Important for Global GDP Growth
As many developing countries have grown more quickly and come to account for larger
shares of world output, their GDP growth rates have become more important in
determining overall world growth. At the same time, growth in the richer economies has
tended to slow over time.
Source: IMF, World Economic Outlook. The group of “advanced economies” in the
chart excludes Japan, Germany, and United States, which are shown separately. World
growth is calculated using GDP weights, with GDP measured at market prices. Partial
data for the 2010s.

Countries (2 of 5)
2. Unsustainable macroeconomic policies that cause high
inflation and unstable output and employment
– If governments cannot pay for debts through taxes, they
can print money to finance debts.
– Seigniorage is paying for real goods and services by
printing money.
– Seigniorage generally leads to high inflation.
– High inflation reduces the real cost of debt that the
government has to repay and reduces the real value of
repayments for lenders.
– High and variable inflation is costly to society; unstable
output and employment is also costly.

Countries (3 of 5)
3. Lack of financial markets that allow transfer of funds from savers to
borrowers
– Banks frequently lend funds to poor or risky projects.
– Loans may be made on the basis of personal connections
rather than prospective returns, and government safeguards
against financial fragility, such as bank supervision, tend to be
ineffective due to incompetence, inexperience, and outright
fraud.
– Usually harder in developing countries for shareholders to find
out how a firm’s money is being spent or to control firm
managers.
– The legal framework for resolving asset ownership in cases of
bankruptcy typically is also weak.

Countries (4 of 5)
4. Where exchange rates are not pegged outright (as in China), they
tend to be managed more heavily by developing-country
governments. Government measures to limit exchange rate flexibility
reflect both a desire to keep inflation under control and the fear that
floating exchange rates would be subject to huge volatility in the
relatively thin markets for developing-country currencies. There is a
history of allocating foreign exchange through government decree
rather than through the market, a practice (called exchange control)
that some developing countries still maintain. Most developing
countries have, in particular, tried to control capital movements by
limiting foreign exchange transactions connected with trade in assets.
More recently, however, many emerging markets have opened their
capital accounts.

Countries (5 of 5)
5. Natural resources or agricultural commodities make up an
important share of exports for many developing countries.
– For example, Russian petroleum, Malaysian timber, South
African gold, and Colombian coffee.
6. Attempts to circumvent government controls, taxes, and
regulations have helped to make corrupt practices such as
bribery and extortion a way of life in many developing countries.
– Due to government control of the economy and weak
enforcement of economic laws and regulations,
underground economies and corruption flourish.

Commodity Price Index
Over the past two decades, aggregate commodity prices have
experienced a boom-bust cycle.
Source: IMF. All Commodity Price Index (2016 = 100). Includes both
fuel and non-fuel indices.

Figure 22.2 Corruption and Per Capita
Output
Corruption tends to rise as real per capita output falls.
Note: The figure plots 2018 values of an (inverse) index of corruption and 2018 values of PPP-adjusted
real per capita output, measured in constant 2010 U.S. dollars (the amount a dollar could buy in the
United States in 2010). The straight line represents a statistician’s best guess of a country’s corruption
level based on its real per capita output.
Source: Transparency International, Corruption Perception Index; World Bank, World Development
Indicators.

Developing-Country Borrowing and Debt
• Another common characteristic for many low- and middle-income
countries is that they have traditionally borrowed from foreign
countries.
– Financial asset flows from foreign countries are able to finance
investment projects, eventually leading to higher production and
consumption.
– But some investment projects fail and other borrowed funds are
used primarily for consumption purposes.
– Some countries have defaulted on their foreign debts when the
domestic economy stagnated or during financial crises.
– But this trend has recently reversed as these countries have
begun to save.

The Economics of Financial Inflows to
Developing Countries
• national saving investment the current account
 
– where the current account is approximately equal to
the value of exports minus the value of imports.
• Countries with national saving less than domestic
investment will have financial asset inflows and a
negative current account (a trade deficit).

Table 22.3 Cumulative Current Account Balances of
Major Oil Exporters, Other Developing Countries, and
Advanced Countries, 1973–2019 (Billions of Dollars)
Blank
Major Oil Exporters
Other Developing
Countries
Advanced
Countries
1973–1981 253 negative 246 negative 184
1982–1989 negative 65 negative 143 negative 427
1990–1998 negative 58 negative 523 negative 106
1999–2019 5,313 negative 852 negative 758
246
 184

65
 143
 427

58
 523

106

852
 758

Source: International Monetary Fund, International Financial Statistics and World
Economic Outlook data. Global current accounts generally do not sum to zero because of
errors, omissions, and the exclusion of some countries in some periods.

The Problem of Default (1 of 6)
A financial crisis may involve
1. a debt crisis: an inability to repay sovereign
(government) or private sector debt.
2. a balance of payments crisis under a fixed exchange
rate system.
3. a banking crisis: bankruptcy and other problems for
private sector banks.

• A debt crisis in which governments default on their debt
can be a self-fulfilling mechanism.
– Fear of default reduces financial asset inflows and
increases financial asset outflows (capital flight),
decreasing investment and increasing interest rates,
leading to low aggregate demand, output, and
income.
– Financial asset outflows must be matched with an
increase in net exports or a decrease in official
international reserves in order to pay individuals and
institutions who desire foreign funds.

– Otherwise, the country cannot afford to pay those
who want to remove their funds from the domestic
economy.
– The domestic government may have no choice but to
default on its sovereign debt (paid for with foreign
funds) when it comes due and when investors are
unwilling to reinvest.

• In general, a debt crisis can quickly magnify itself: it
causes low income and high interest rates, which make
government and private sector debts even harder to
repay.
– High interest rates cause high interest payments for
both the government and the private sector.
– Low income causes low tax revenue for the
government.
– Low income makes loans made by private banks
harder to repay: the default rate increases, which may
cause bankruptcy.

• If the central bank tries to fix the exchange rate, a balance of
payment crisis may result along with a debt crisis.
– Official international reserves may quickly be depleted because
governments and private institutions need to pay for their debts
with foreign funds, forcing the central bank to abandon the fixed
exchange rate.
• A banking crisis may result from a debt crisis.
– High default rates on loans made by banks reduce their income
to pay for liabilities and may increase bankruptcy.
– If depositors fear bankruptcy due to possible devaluation of the
currency or default on government debt (assets for banks), then
they will quickly withdraw funds from banks (and possibly
purchase foreign assets), leading to actual bankruptcy.

• A debt crisis, a balance of payments crisis, and a banking
crisis can occur together, and each can make the other
worse.
– Each can cause aggregate demand, output, and
employment to fall (further).
• If people expect a default on sovereign debt, a currency
devaluation, or bankruptcy of private banks, each can
occur, and each can lead to another.

Alternative Forms of Financial Inflow (1 of 3)
1. Bond finance: government or private sector bonds are
sold to foreign individuals and institutions.
2. Bank finance: commercial banks or securities firms
lend to foreign governments or foreign businesses.
3. Official lending: the World Bank, Inter-American
Development Bank, or other official agencies lend to
governments.
– Sometimes these loans are made on a “concessional”
or favorable basis, in which the interest rate is low.

4. Foreign direct investment: a firm directly acquires or
expands operations in a subsidiary firm in a foreign
country.
– A purchase by Ford of a subsidiary firm in Mexico is
classified as foreign direct investment.
5. Portfolio equity investment: a foreign investor
purchases equity (stock) for his portfolio.
– Privatization of government-owned firms in many
countries has created more equity investment
opportunities for foreign investors.

• Debt finance includes bond finance, bank finance, and
official lending.
• Equity finance includes direct investment and portfolio
equity investment.
• While debt finance requires fixed payments regardless of
the state of the economy, the value of equity finance
fluctuates depending on aggregate demand and output.

The Problem of “Original Sin” (1 of 4)
• Sovereign and private sector debts in the United States,
Japan, and European countries are mostly denominated
in their respective currencies.
• But when poor and middle-income countries borrow in
international financial capital markets, their debts are
almost always denominated in US $, yen, or euros: a
condition called “original sin.”

• When a depreciation of domestic currencies occurs in the
United States, Japan, or European countries, liabilities
(debt) that are denominated in domestic currencies do
not increase, but the value of foreign assets increases.
– A devaluation of the domestic currency causes an
increase in net foreign wealth.

• When a depreciation/devaluation of domestic currencies
occurs in most poor and middle-income economies, the
value of their liabilities (debt) rises because their liabilities
are denominated in foreign currencies.
– A devaluation of the domestic currency causes a
decrease in net foreign wealth.

– In particular, a fall in aggregate demand of domestic
products causes a depreciation/devaluation of the
domestic currency and causes a decrease in net
foreign wealth if assets are denominated in domestic
currencies and liabilities (debt) are denominated in
foreign currencies.
– This is a situation of “negative insurance” against a
fall in aggregate demand.

The Debt Crisis of the 1980s (1 of 2)
• In the 1980s, high interest rates and an appreciation of
the U.S. dollar caused the burden of dollar-denominated
debts in Argentina, Mexico, Brazil, and Chile to increase
drastically.
• A worldwide recession and a fall in many commodity
prices also hurt export sectors in these countries.
• In August 1982, Mexico announced that it could not repay
its debts, mostly to private banks.

The Debt Crisis of the 1980s (2 of 2)
• The U.S. government insisted that the private banks
reschedule the debts, and in 1989 Mexico was able to
achieve
– a reduction in the interest rate
– an extension of the repayment period
– a reduction in the principal by 12%
• Brazil, Argentina, and other countries were also allowed
to reschedule their debts with private banks after they
defaulted.

Reforms, Capital Inflows, and the Return
of Crisis (1 of 9)
• The Mexican government implemented several reforms
due to the crisis. Starting in 1987, it
– reduced government deficits.
– reduced production in the public sector (including
banking) by privatizing industries.
– reduced barriers to trade.
– maintained an adjustable fixed exchange rate
(“crawling peg”) until 1994 to help curb inflation.

of Crisis (2 of 9)
• It extended credit to newly privatized banks with loan
losses.
– Losses were a problem due to weak enforcement or
lack of asset restrictions and capital requirements.
• Political instability and loan defaults at private banks
contributed to another crisis in 1994, after which the
Mexican government allowed the value of the peso to
fluctuate.

of Crisis (3 of 9)
• Starting in 1991, Argentina carried out similar reforms:
– It reduced government deficits.
– It reduced production in the public sector by
privatizing industries.
– It reduced barriers to trade.
– It enacted tax reforms to increase tax revenues.
– It enacted the Convertibility Law, which required that
each peso be backed with 1 U.S. dollar, and it fixed
the exchange rate to 1 peso per U.S. dollar.

of Crisis (4 of 9)
• Because the central bank was not allowed to print more
pesos without having more dollar reserves, inflation
slowed dramatically.
• Yet inflation was about 5% per annum, faster than U.S.
inflation, so that the price/value of Argentinean goods
appreciated relative to U.S. and other foreign goods.
• Due to the relatively rapid peso price increases, markets
began to speculate about a peso devaluation.
• A global recession in 2001 further reduced the demand of
Argentinean goods and currency.

of Crisis (5 of 9)
• Maintaining the fixed exchange rate was costly because
high interest rates were needed to attract investors,
further reducing investment and consumption
expenditure, output, and employment.
• As incomes fell, tax revenues fell and government
spending rose, contributing to further peso inflation.

of Crisis (6 of 9)
• Argentina tried to uphold the fixed exchange rate, but the
government devalued the peso in 2001 and shortly
thereafter allowed its value to fluctuate.
• It also defaulted on its debt in December 2001 because
of the unwillingness of investors to reinvest when the
debt was due.

of Crisis (7 of 9)
• Brazil carried out similar reforms in the 1980s and 1990s:
– It reduced production in the public sector by
privatizing industries.
– It reduced barriers to trade.
– It enacted tax reforms to increase tax revenues.
– It fixed the exchange rate to 1 real per U.S. dollar.
– But government deficits remained high.

of Crisis (8 of 9)
• High government deficits led to inflation and speculation
about a devaluation of the real.
• The government did devalue the real in 1999, but a
widespread banking crisis was avoided because Brazilian
banks and firms did not borrow extensively in dollar-
denominated assets.

of Crisis (9 of 9)
• Chile suffered a recession and financial crisis in the
1980s, but thereafter
– enacted stringent financial regulations for banks.
– removed the guarantee from the central bank that
private banks would be bailed out if their loans failed.
– imposed controls on flows of short-term assets, so
that funds could not be quickly withdrawn during a
financial panic.
– granted the central bank independence from fiscal
authorities, allowing slower money supply growth.
• Chile avoided a financial crisis in the 1990s.

International Reserves Held by
Developing Countries
Since the 1990s, developing countries have sharply increased their
holdings of foreign currency reserves, mostly U.S. dollars.
Source: World Bank, World Development indicators. In this chart,
developing countries include low- and middle-income countries
according to the World Bank’s country income classification.

East Asia: Success and Crisis (1 of 2)
• Before the 1990s, Indonesia, Korea, Malaysia,
Philippines, and Thailand relied mostly on domestic
saving to finance investment.
• But afterward, foreign funds financed much of
investment, and current account balances turned
negative.

East Asia: Success and Crisis (2 of 2)
• Despite the rapid economic growth in East Asia between
1960 and 1997, growth was predicted to slow as
economies “caught up” with Western countries.
– Most of the East Asian growth during this period is
attributed to an increase in physical capital and
education.
– The marginal productivities of physical capital and
education are diminishing: as more physical capital
was built and as more people acquired more
education, further increases added less productive
capability to the economy.

The Asian Financial Crises (1 of 6)
• More directly related to the East Asian crises are issues
related to economic laws and regulations:
1. Weak enforcement of financial regulations and a lack of
monitoring caused commercial firms, banks, and
borrowers to engage in risky or even fraudulent
activities: moral hazard.
– Ties between commercial firms and banks on the one
hand and government regulators on the other hand
allowed risky investments to occur.

2. Nonexistent or weakly enforced bankruptcy laws and
loan contracts worsened problems after the crisis
started.
– Financially troubled firms stopped paying their debts,
and they could not operate without cash, but no one
would lend more until previous debts were paid.
– But creditors lacked the legal means to confiscate
and sell assets to other investors or to restructure the
firms to make them productive again.

• The East Asian crisis started in Thailand in 1997, but quickly
spread to other countries.
– A fall in real estate prices, and then stock prices,
weakened aggregate demand and output in Thailand.
– A fall in aggregate demand in Japan, a major investor
and export market, also contributed to the economic
slowdown.
– Speculation about a devaluation of the baht occurred,
and in July 1997 the government devalued the baht
slightly, but this only invited further speculation.
• Malaysia, Indonesia, Korea, and the Philippines soon faced
speculations about the value of their currencies.

• Most debts of banks and firms were denominated in U.S.
dollars, so that devaluations of domestic currencies
would make the burden of the debts in domestic currency
increase.
– Bankruptcy and a banking crisis would have resulted.
• To maintain fixed exchange rates would have required
high interest rates and a reduction in government deficits,
leading to a reduction in aggregate demand, output, and
employment.
– This would have also led to widespread default on
debts and a banking crisis.

• All of the affected economies except Malaysia turned to
the IMF for loans to address the balance of payments
crises and to maintain the value of the domestic
currencies.
– The loans were conditional on increased interest
rates (reduced money supply growth), reduced
budget deficits, and reforms in banking regulation and
bankruptcy laws.
• Malaysia instead imposed controls on flows of financial
assets so that it could increase its money supply (and
lower interest rates), increase government purchases,
and still try to maintain the value of the ringgit.

• Because consumption and investment expenditure
decreased with output, income, and employment, imports
fell and the current account increased after 1997.

Lessons of Crises (1 of 4)
1. Fixing the exchange rate has risks: governments desire
to fix exchange rates to provide stability in the export
and import sectors, but the price to pay may be high
interest rates or high unemployment.
– High inflation (caused by government deficits or
increases in the money supply) or a drop in demand
of domestic exports leads to an overvalued currency
and pressure for devaluation.
– Given pressure for devaluation, commitment to a
fixed exchange rate usually means high interest
rates (a reduction in the money supply) and a
reduction in domestic prices.

– Prices can be reduced through a reduction in government
deficits, leading to a reduction in aggregate demand,
output, and employment.
– A fixed currency may encourage banks and firms to
borrow in foreign currencies, but a devaluation will cause
an increase in the burden of this debt and may lead to a
banking crisis and bankruptcy.
– Commitment a fixed exchange rate can cause a financial
crisis to worsen: high interest rates make loans for
individuals and institutions harder to repay, and the central
bank cannot freely print money to give to troubled banks
(cannot act as a lender of last resort).

2. Weak enforcement of financial regulations can lead to
risky investments and a banking crisis when a currency
crisis erupts or when a fall in output, income, and
employment occurs.
3. Liberalizing financial asset flows without implementing
sound financial regulations can lead to capital flight
when investments lose value during a recession.

4. The importance of expectations: even healthy
economies are vulnerable to crises when expectations
change.
– Expectations about an economy often change when
other economies suffer from adverse events.
– International crises may result from contagion: an
adverse event in one country leads to a similar event
in other countries.

Reforming the World’s Financial
“Architecture” (1 of 3)
• Countries face tradeoffs when trying to achieve the
following goals:
– exchange rate stability
– financial capital mobility
– autonomous monetary policy devoted to domestic
goals
• Generally, countries can attain only two of the three
goals, and as financial assets have become more mobile,
maintaining a fixed exchange with an autonomous
monetary policy has been difficult.

Preventative (“prophylactic”) measures:
1. Better monitoring and more transparency: more
information allows investors to make sound financial
decisions in good and bad times.
2. Stronger enforcement of financial regulations: reduces
moral hazard.
3. Deposit insurance and reserve requirements.
4. Increased equity finance relative to debt finance.
5. Increased credit for troubled banks through central
banks or the IMF?

Coping with crisis—reforms for after a crisis occurs:
1. Bankruptcy procedures for default on sovereign debt
and improved bankruptcy law for private sector debt.
2. A bigger or smaller role for the IMF as a lender of last
resort for governments, central banks, and even the
private sector? (See 5 above.)
– Moral hazard versus the benefit of insurance before
and after a crisis occurs.

Global Financial Cycles and Movements
in the Developing World’s GDP
The GDP growth rate of poorer countries moves closely in tandem with the global
financial cycle.
Source: GFCy: Miranda-Agrippino and Rey. “U.S. Monetary Policy and the Global
Financial Cycle,” Review of Economic Studies 87 (2020). Yearly observations
on GFCy are averages of monthly observations. GDP growth in emerging and
developing economies: World Economic Outlook database, April 2020.

Geography, Human Capital, and
Institutions (1 of 4)
• What causes poverty?
• A difficult question: economists argue about whether
geography or human capital is more important in
influencing economic and political institutions, and
ultimately poverty.

Geography matters:
1. International trade is important for growth, and ocean
harbors and a lack of geographical barriers foster trade
with foreign markets.
– Landlocked and mountainous regions are predicted to
be poor.
2. Also, geography is said to have determined institutions,
which may play a role in development.
– Geography determined whether Westerners
established property rights and long-term investment
in colonies, which in turn influenced economic growth.

– Geography determined whether Westerners died from
malaria and other diseases. With high mortality rates, they
established practices and institutions based on quick
plunder of colonies’ resources, rather than institutions
favoring long-term economic growth.
– Plunder led to property confiscation and corruption,
even after political independence from Westerners.
– Geography also determined whether local economies were
better for plantation agriculture, which resulted in income
inequalities and political inequalities. Under this system,
equal property rights were not established, hindering long-
term economic growth.

Human capital matters:
1. As a population becomes more literate, numerate, and
educated, economic and political institutions evolve to
foster long-term economic growth.
– Rather than geography, Western colonization, and
plantation agriculture, the amount of education and
other forms of human capital determine the existence
or lack of property rights, financial markets,
international trade, and other institutions that
encourage economic growth.

Summary (1 of 3)
1. Some countries have grown rapidly since 1960, but
others have stagnated and remained poor.
2. Many poor countries have extensive government control
of the economy, unsustainable fiscal and monetary
policies, lack of financial markets, weak enforcement of
economic laws, a large amount of corruption, and low
levels of education.
3. Many developing economies have traditionally borrowed
from international capital markets, and some have
suffered from periodic sovereign debt crises, balance of
payments crises, and banking crises.

Summary (2 of 3)
4. Sovereign debt, balance of payments, and banking
crises can be self-fulfilling, and each crisis can lead to
another within a country or in another country.
5. “Original sin” refers to the fact that poor and middle-
income countries often cannot borrow in their domestic
currencies.
6. Fixing exchange rates may lead to financial crises if the
country is unwilling to restrict monetary and fiscal
policies.

Summary (3 of 3)
7. Fixing exchange rates may lead to financial crises if the
country is unwilling to restrict monetary and fiscal
policies.
8. Weak enforcement of financial regulations causes a
moral hazard and may lead to a banking crisis,
especially with free movement of financial assets.
9. Geography and human capital may influence economic
and political institutions, which in turn may affect long-
term economic growth.

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